Fiscal Policy: The Trump Administration Could Test Whether Deficits Help the Economy

Here’s a surprising conclusion you reach when you start to game out what economic policy will look like in Donald J. Trump’s administration: While many details of his policy agenda are likely to be staunchly opposed by the left, Mr. Trump appears likely to enact a fun-house mirror version of what many liberal economists have advocated for years: Keynesian fiscal stimulus.

Mr. Trump did not run a campaign with many detailed proposals, but he promised to cut taxes significantly, rebuild and expand infrastructure and maybe increase military spending. Together those moves would most likely increase the budget deficit substantially. That risks increasing interest rates and inflation, which could dampen the pro-growth effects of any tax cut and government spending.

If that turns out to be the policy reality of the next few years, it would be a real-world test of an argument liberal economists have made for years: that higher deficits could help end an era of “secular stagnation” and spur faster growth. Somewhat higher inflation would actually be a feature, not a bug, of the policy approach.

The most detailed policy proposal the Trump campaign issued was on tax policy. It broadly tracks the priorities of a Republican Party that will control both houses of Congress.

So expect major tax cuts, which will especially benefit wealthy Americans and businesses. Mr. Trump’s plan included cutting the rate on the highest earners from its current 39.6 percent to 25 percent and cutting the corporate income tax rate from 35 percent to 15 percent.

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Of course any actual changes to tax policy will depend on the results of laborious negotiations with Congress — no campaign policy proposal is ever enacted exactly as written. But Mr. Trump’s proposal is similar to a proposal by House Republicans, and it is quite clear this is the direction Congress will want to go.

Mr. Trump has often cited his experience as a real estate developer and promised he would radically increase spending on public infrastructure. He even said at one point in the campaign that he would double the $275 billion infrastructure plan that Hillary Clinton proposed. He specifically cited infrastructure spending again early Wednesday morning in his victory speech in New York.

Some version of this infrastructure policy has a good chance of being enacted. Republicans in Congress are generally on board with the idea of spending on roads, bridges airports and other projects; opposition to such a proposal during the Obama administration has been more tactical than ideological.

PhotoTV monitors displaying results of the the United States presidential election at an outdoor cafe in Athens.Credit Louisa Gouliamaki/Agence France-Presse — Getty Images

Even if the details of a Trump infrastructure plan take a different form than the one that left-of-center economists have advocated as a cure for persistently slow growth, the result in terms of the macroeconomic effects should be similarly positive.

But then there are the tax cuts. In the simplest math of fiscal policy, lower taxes plus more spending equal higher budget deficits. Mr. Trump resorted to vague hand-waving about any spending cuts to offset those changes, promising instead that faster growth would prevent the deficit from rising.

Most hardheaded analysis — including from those sympathetic ideologically — suggests this is wrong. The conservative-leaning Tax Foundation, for example, estimates that Mr. Trump’s tax plan would reduce federal revenue by about $12 trillion over the next decade, and faster growth would offset only about $2 trillion of that.

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Assuming that those forecasts are right and that Mr. Trump’s tax and spending plans sharply increase the deficit, the open question is what it means for the economy. For the last few years, the world has suffered from a chronic shortage of demand, depressing inflation and interest rates worldwide.

If those conditions persist, a Trump administration may have some room to expand deficits without triggering a spike in interest rates that would undo any economic boost those deficits create.

But many economists don’t see it working out that way. Mark Zandi, chief economist at Moody’s Analytics, was skeptical in a much-discussed paper released earlier in the year estimating the economic impact of a Trump administration. He assumed that if Mr. Trump’s policies were taken at face value, it would increase the deficit from 3.5 percent of G.D.P. this year to more than 10 percent by the end of Mr. Trump’s term. He said this would cause the Federal Reserve to raise interest rates above 6 percent in 2018 to prevent inflation.

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It’s unwise to extrapolate from short-term moves in financial markets what will happen to the economy over years ahead. But shifts in the markets on Wednesday suggest that investors are pricing in some significant chance of this happening.

The yield on Treasury bonds fell initially Tuesday night as Mr. Trump’s victory looked more probable and investors sought a safe-haven investment. But Wednesday, rates actually rose 0.11 percentage points, which suggests global investors think that higher rates are in the United States’s future. Measures of expected inflation in the bond market rose as well.

“While things change fast, for now the market seems to think of a Trump presidency largely as inflationary,” said Roberto Perli, an economist with Cornerstone Macro, in a research note Wednesday morning.

Even for people who don’t like Mr. Trump’s proposed tax cuts or the rest of his policy agenda, if he gets his way on taxes and infrastructure spending, it will be a test of whether deficits really matter in a world that has been locked in a slow-growth reality for years.